No, undo space is reused but files don't shrink.
In the normal state, undo tablespace should be always "full" (occupied by extents/segments), if it is not then it is oversized and you're wasting disk space.

UNDO TS remains occupied till undo_retention. When new transaction requires a space, transaction which are expired are removed from undo segments and space is made is available. By default Oracle does not guarantee undo retention.

In 10G there is parameter undo_retention_gurantee this one guarntees undo retention. So check if it is set. If there is no space available in UNDO and old segments are not expired, new transactions will abort.

You dont need to shrink the UNDO segments like the old rollback segments if the undo management is AUTO